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The Consumption-Wealth Ratio Under Asymmetric Adjustment

  • Vasco Gabriel

    (Department of Economics, University of Surrey and NIPE, University of Minho)

  • Fernando Alexandre

    (Department of Economics and NIPE, University of Minho)

  • Pedro Bação


    (GEMF and Faculty of Economics, University of Coimbra)

This paper argues that nonlinear adjustment may provide a better explanation of fluctuations in the consumption-wealth ratio. The nonlinearity is captured by a Markov-switching vector error-correction model that allows the dynamics of the relationship to differ across regimes. Estimation of the system suggests that these states are related to the behaviour of financial markets. In fact, estimation of the system suggests that short-term deviations in the consumption-wealth ratio will forecast either asset returns or consumption growth: the first when changes in wealth are transitory; the second when changes in wealth are permanent. Our approach uncovers a richer and more complex dynamics in the consumption-wealth ratio than previous results in the literature, whilst being in accordance with theoretical predictions of a simple model of consumption under uncertainty.

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Paper provided by GEMF - Faculdade de Economia, Universidade de Coimbra in its series GEMF Working Papers with number 2007-06.

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Length: 33 pages
Date of creation: 2007
Date of revision:
Publication status: Published in Studies in Nonlinear Dynamics & Econometrics 12(4): article 3, 2008
Handle: RePEc:gmf:wpaper:2007-06
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